Foreign Relations of the United States, 1981–1988, Volume XXXVIII, International Economic Development; International Debt; Foreign Assistance

341. Memorandum From the Chairman of the Third World Hunger Study (Keating) to the President’s Assistant for National Security Affairs (McFarlane) and the President’s Assistant for National Security Affairs (Poindexter)¹

Washington, August 16, 1985

SUBJECT

• Development Assistance and Private Enterprise: When Will the Reagan Revolution Begin?

The purpose of this memorandum is to call attention to one of the major unmet goals of this Administration—encouraging Third World economic growth through the private sector—and to suggest the options which remain available to effect real change within the next three years. More than ever we are at a turning point. The time remaining for a decision and effective initiative is running out.

Summary

The President at Cancun in 1981 articulated a positive program of action for economic development which underscored the need to encourage Third World growth through the private sector. On March 17, 1980, the President stated that “for too long at official levels we have been apologetic about, if not downright hostile towards, American capitalism as a model for economic development . . .”.² At a time when economic policies in the Third World (and industrial nations) are shifting towards market-oriented approaches, the growing American economy driven by the private sector, and the developing countries which have copied the American model, provide irresistible examples impelling significant changes in Third World economies. Thus the President’s goals as spelled out at Cancun were timely and have the potential of delivering international economic growth through the stimulation of private enterprise. The strategy and mechanisms for carrying out the goals are, however, flawed, and the President’s program remains unfulfilled.

The changing economic circumstances in the Third World not only create a new context for political and economic relations, but also present an unprecedented opportunity to strengthen the West’s position relative to that of the Soviet Union.³ Many Third World leaders now recognize that rigid Marxist-Socialist models will not yield economic and industrial growth. Increasingly concerned with the “politics of economics” and not the “politics of Socialism”, they look to market-oriented approaches to rebuild shattered economies and are just beginning to initiate practical policies which will gain momentum over the next 10 years. The Soviets have few real resources to counter these economic and political trends. Unable to provide much of a growth market for Third World exports or much in the way of economic assistance, they are at a distinct disadvantage in a system of free trade where the West and the Third World are inextricably tied together by the mutuality of economic interests. In addition, Soviet economic and financial constraints over the next 10 years will make Moscow increasingly less able to compete in non-military sectors. These converging economic forces give us opportunities to enhance U.S. security interests in key Third World countries, if we take advantage of them.

AID, as currently structured, has shown over the past 4½ years that it is incapable of carrying out the President’s mandate of encouraging real economic growth through private initiative. Although its resource transfers may support short-term political stability, its overwhelmingly government-to-government economic assistance is helping perpetuate centralized economic controls which stifle private enterprise and retard or stop real economic growth. AID’s limited understanding of the private sector is demonstrated by loans and programs which show little positive correlation with private sector growth, and its lack of interest in private initiative is evidenced by the fact that almost none of the AID budget for foreign assistance (ca. $13 billion per year) goes to the private sector. Moreover, at a recent meeting of the State Department’s Subcommittee on Food, Hunger and Agriculture in Developing Countries, AID officials stated that the private sector efforts of AID have not been strongly supported internally and that another decade would be needed to institute the needed shifts in emphasis towards private enterprise (AID’s Bureau for Private Enterprise is an underfunded, largely ignored appendage). These and other considerations make it clear that AID is inadequate to the fundamental long-term task of fostering the role of private enterprise in the process of Third World economic development. What is urgently needed is a transfer of resources away from AID to an environment which understands the private sector (e.g., an expanded OPIC or a U.S. International Development Corporation). Unless the Administration is prepared to do this, the President’s Cancun goals will not be fulfilled. (AID’s legislation and institutional orientation reflect the dominance of the humanitarian aspect of development assistance and it seems reasonable that AID should continue to be predominantly a humanitarian institution.) End of Summary.

THE CHANGING ECONOMIC CIRCUMSTANCES

Socialist systems which have dominated the economies of developing countries for several decades have failed to achieve economic growth. They have emphasized urban development at the expense of the countryside and its agriculture, driving farmers into mere subsistence. Central planners set up inefficient state enterprises at enormous expense, bankrupting their economies. Times got tougher in the seventies. Two oil hikes, two recessions, accumulated debt and high interest rates all made development more difficult. With the failure of producer cartels and OPEC’s current problems, developing countries now realize they have less collective power than earlier imagined.

Looking for ways out of their economic difficulties and assistance for their nation-building needs, developing countries have finally perceived that the Soviet Union and its client states are dismal examples of agricultural and industrial productivity. Unable to supply much economic assistance, the Soviet Union has had to bind them to its side with supplies of surplus military equipment. Meanwhile, western development agencies built ponderous bureaucracies at home and abroad to administer rural welfare to the poorest of the poor, without contributing to economic growth.

In this dark landscape, there is light and it comes from an expanding American economy which stands as a model and pulling engine for world economic growth. Among developing countries, those with the most open economies and closest ties with the United States (e.g., the ASEAN countries) have most effectively overcome the last decade’s adverse economic circumstances. Technologies from US-sponsored research are opening a new era of productivity for Third World farmers. Because of oil conservation, OPEC’s cartel has been broken with the prospect that developing countries can now afford pesticides, fertilizers and fuel for irrigation and machinery. Underneath the surface of state regulation, burgeoning “second economies” are breaking open old controls, causing centrally directed economies to change. Third World leaders, once enamored of Socialist models, are now betting on market-oriented policy changes in four critical areas:

— agricultural prices;

— marketing reform and liberalization;

— input supply and distribution;

— private sector involvement in agriculture and industry.

THE CHALLENGE OF THE INTERIM PERIOD

Third World governments, once dominated by Socialist economic systems, are now attempting to liberalize their economies and make them more efficient. They have agreed to policy reforms stipulated by the IMF, and have made progress towards better economic and financial management. However, the actual implementation of critical policy measures, loans and projects has slipped in many of these countries. This means that even longer periods of economic austerity must be endured before healthier economies can evolve, in some instances up to five years.

We must also reckon with the political vulnerability of Third World leaders who have taken the hard policy decisions. While setting in motion new reform measures which will yield positive results several years hence, these leaders must simultaneously contend with urgent political and social pressures exacerbated by the interim period of economic hardship. If not handled properly, such pressures could derail efforts to restore economic growth and create the kind of instability which the Soviets so skillfully exploit with their warehouses filled with cheap weaponry ready to be dumped on a vulnerable developing country at a moment’s notice.

THE SPECIAL CASE OF AFRICA

The land is dying in many parts of Africa. South of the steadily encroaching Sahara desert, 29 of the world’s 36 poorest nations require emergency aid to ward off famine. Hunger and malnutrition now threaten over 14 million people. A drought far worse than anything hitherto experienced in the region, plus the instability of regimes and their ill-advised policies, has badly damaged agricultural production driving farmers into mere subsistence. Peasants cut down trees at an alarming rate for money to buy food, rain is not recycled, and irrigation is deteriorating. Moreover, in spite of epidemics and high infant mortality, population pressures are among the greatest in the world with net annual gains of three percent or more, or about a 20 million increase in population a year.

Problems of this magnitude cannot be addressed effectively by the current AID policy of broadly based development from the bottom rung up—a generalized welfare approach which fritters away scarce resources. It is necessary, of course, to send food to feed the starving (the President last year approved the Keating-group’s ten recommendations for achieving more rapid response to Third World food crises).⁴ But helping the landless poor with health, education and other social problems, however laudable, will not solve the underlying structural problems of agriculture stagnation nor produce badly needed fundamental changes and economic growth, particularly during the transitional period to more market-oriented economies. What is needed is a reallocation of available resources on a rational basis to strengthen food-producing capacity, a rigorous approach to agricultural policy reform, and most importantly the motivation of the private sector to provide agricultural inputs, food processing, storage and marketing.

THE U.S. BUSINESS PERSPECTIVE

Over the past six weeks, I have met with influential business leaders in an effort to determine how they viewed Administration efforts to stimulate private enterprise in the Third World. Their reactions may be summarized as follows:

1. US business leaders credit President Reagan with clearly perceiving and articulating the role of the private sector in Third World development. However, they do not feel any more involved in Third World development issues and the possibilities for private sector involvement because of Administration actions than they did 4½ years ago. (Several of them liked the new State Department Subcommittee on Food, Hunger and Agriculture which was created through a recommendation of the Keating-group Third World Hunger Study.)

2. In general, these business leaders do not believe that there has been a just return on the taxpayers’ investment in Third World private sector programs within our federal bureaucracies. They feel that the bureaucratic response to an issue like Third World private sector involvement is, “How can I use this issue to raise my agency above the others, to increase funds under my control and to augment my staff?” Thus, the emphasis in Government seems to them to be not on what counts—production, economic growth and return on investment—but on expanded programs and increased budgets.

3. They feel that if the Administration is really serious about the private sector becoming the motor for Third World development, then the federal bureaucracies (particularly AID) must better understand the dynamics of international business. There must be far greater awareness of what the private sector requires in order to function effectively overseas. Furthermore, if the Administration really believes that US business concerns are part and parcel of US security concerns, then US international businessmen should have greater access to the foreign policy process. Too often intermediaries such as academics, consultants, and lobbyists speak on behalf of the business community to government officials rather than the business leaders themselves.

4. They want a more focussed approach which would permit elements of the private sector to weigh-in on issues directly affecting their effectiveness overseas (for several of them, the great virtue of the Reagan Administration review of the Law of the Sea Treaty was that it opened a previously closed foreign policy process to the ideas and concerns of businessmen most directly concerned with the proposed treaty decisions). Should this take place, then there would be a clearer commitment to business priorities overseas, and improved liaison with the business community at home.

THE IMPLICATIONS FOR U.S. POLICY

The changing economic circumstances in the Third World not only create a new context for political and economic relations, but also present an unprecedented opportunity to strengthen the West’s position relative to that of the Soviet Union. In a system of free trade, the United States and the developing nations are inextricably tied together by the mutuality of economic interests. Strengthening these ties is the growing American economy driven by its private sector which is impelling changes in the economies of both the industrial and Third World countries. President Reagan recognized the importance of the American economic model as an agent for change in his March 17, 1980, speech where he said, “for too long at official levels we have been apologetic about, if not downright hostile towards, American capitalism as a model for economic development . . .”. The President then brought this point forcefully home at the Cancun Summit in 1981 when he articulated a positive program of economic development which underscored the crucial role of the private sector in Third World economic development.

Although budgetary constraints require cuts in our development assistance, economic growth in the United States and the Free World is creating private investment capital that, if properly encouraged, could help turn around the economies of developing countries. Third World leaders are increasingly aware of this and recognize that their countries’ economic salvation lies in the West, with the East providing little in the way of credible nation-building alternatives.

The Soviet Bloc has few real resources to counter the economic forces exerting pressures for change in the Third World. It is not able to provide much of a growth market for Third World exports. The supply of Soviet oil to favored developing countries will diminish with faltering domestic production and increasing needs at home. Domestic shortages of goods and skilled manpower will limit commodity and project aid. Foreign exchange stringencies will severely restrict hard currency loans. In sum, Soviet economic and financial constraints will make Moscow even less inclined to accept costly new burdens like Cuba and Vietnam. In trimming outlays throughout their empire, they also must pare economic support for client states. Under these circumstances, the Soviet Union over the next 10 years will rely more heavily on shipments of arms to sustain its influence in the Third World.

An immediate challenge to U.S. foreign policy is to have Third World leaders stay on course in redressing their economies and not yield to short-term political expediency at the expense of their country’s future economic interests. At this point in history, we have, in many Third World countries, a major sunk investment in the form of World Bank loans, IMF stand-by arrangements and commercial financing that will be lost if policy changes are not upheld and economic growth renewed. In this context, we need new initiatives to support policy reform and private sector enterprise to help bridge the gap between economic stagnation and recovery. We need as well more innovative measures to promote pricing policies which reflect market forces in order to foster efficient allocation of resources (e.g., decontrol of farmgate prices, termination of price controls on industrial products, and lifting ceilings on interest rates). An example of the latter is the Keating-group “Food for Progress” proposal to help reduce the food risk to Third World governments undertaking agricultural price and policy reform.⁵

Another urgent requirement is the need to blunt the current policy drift in AID which is counter to many of the President’s private sector objectives. This will require (a) shifting the focus of development resources and programs toward more rigorous policy conditionality and self-sustaining economic growth, and (b) transferring resources from AID to another new institution (an expanded OPIC or a U.S. International Development Corporation) which would be better able to carry out the President’s mandate of promoting economic growth in Third World countries through direct involvement of the U.S. sector and support of indigenous private enterprise.

CONCLUSIONS AND RECOMMENDATIONS

In its first term, the Reagan Administration missed an opportunity to make AID an effective instrument of development assistance. However, the success of the Administration’s domestic economic policies now enhance its ability to generate a program of development assistance and international private investment which American people can understand and the American Congress can support. At the same time, a complex of factors has given us another chance to promote economic growth, strengthen political relations, and advance US security interests in key Third World countries. We cannot afford to let the occasion slip by again. The reasons why may be set forth as follows:

— By continuing to move virtually all US aid from US bureaucracy to foreign bureaucracy without involving the private sector, we are helping perpetuate centralized economic controls in key LDC countries which stifle private enterprise and retard or stop real economic growth.

— By continuing to provide economic assistance that is overwhelmingly government-to-government, we are placing the security of strategic pieces of real estate in jeopardy (e.g., the Philippines and Subic Bay).⁶ Political resistance is inevitable when people realize that centralized economic controls will not give them a stake in the economy nor yield industrial and economic growth.

— By continuing to channel our foreign assistance through LDC central governments, we are denying ourselves an unprecedented opportunity to take advantage of economic forces for positive change in the Third World which would strengthen the West’s position relative to the Soviet Union.

In examining AID, we have found the agency excessively layered with minute subdivisions of labor which do not result in increased productivity. We have asked the following questions:

a. Are the “four pillars” of development, as interpreted by AID, the right ones?

b. Are financial resources targeted at the priority areas of opportunity?

c. Are personnel resources deployed in a rational manner consistent with priority tasks?

d. Does current AID policy formulation effectively support U.S. foreign policy, national security and trade interests?

e. Are AID programs, other than emergency relief, comprehensible to the American public and Congress?

f. Is AID decision-making plugged into an analytical framework which examines all foreign assistance instrumentalities in terms of objectives and trade-offs?

g. Has AID succeeded in promoting private enterprise in Third World nations?

The answer to each of the above critical questions is in large part “no”. If AID were to be restructured in order to seize new opportunities in the Third World and realize the goals of the Reagan Administration, it would first be necessary to regroup available resources into the areas which matter most: agricultural development, policy reform and private sector initiatives. A proper analytical framework would be required to ensure that foreign policy, national security and trade interests were properly meshed. Then it would be necessary to revitalize AID as an organization by further integrating it into the Foreign Service, attracting new talent, and rewarding productive work with career incentives.

There would, however, be considerable resistance within AID to these required changes and considerable time would be needed for their implementation. This would be particularly true of private sector initiatives, and in this respect we are in agreement with the conclusions of the Peterson Commission in 1972, the Reagan Transition Team in 1980–81, the Carlucci Commission of 1982, a subcommittee of the President’s Task Force on International Private Enterprise in 1984, and others, that AID is the wrong institution to carry out the private sector mandate. These groups proposed that resources be transferred from AID to an environment which understands the private sector (e.g., an expanded OPIC or a US International Development Corporation). Unless the Administration is prepared to do this, the President’s Cancun goals will not be fulfilled. (AID’s legislation and institutional orientation reflect the dominance of the humanitarian aspect of development assistance, and it seems reasonable that AID should continue to be predominantly a humanitarian institution.)

In order to implement the Administration’s commitment to market-oriented economic development in the Third World and the supporting role of U.S. private investment, the following specific step is recommended:

— The issuance of a Special Executive Order directing that the President’s Cancun goals be implemented with modalities established for stimulating U.S. private sector investment and indigenous private enterprise in the Third World. This executive order would also mandate that an improved institutional capacity be developed for support of private enterprise in the Third World involving reorganization and transfer of AID private sector responsibilities to a more appropriate institution. The executive order would then name a new director of the International Development Cooperation Agency (IDCA) to carry out the mandate.

(The AID Director is currently Acting Director of IDCA.)

1. Source: Department of State, Executive Secretariat, S/S–I Records, Official Correspondence of Deputy Secretary John C. Whitehead, July 1982–Jan 1989, Lot 89D139: JCW—Memos To/From other agencies 85. No classification marking. A stamped notation reads: “Aug 26 1985, J.C.W. has seen.” Whitehead wrote at the top of the memorandum: “Peter McPherson, Can we talk about this?”
2. Reagan delivered a speech to the Chicago Council on Foreign Relations on March 17, 1980. A copy of the speech is in the Reagan Library, 1980 Transition Papers, Foreign Policy (Richard Allen), [Foreign Policy Advisory Board—Meeting 11/21/1980—Participant Binders—Allen].
3. Economic Forces for Change in the Third World, NI 84–004, December 1985 (C). [Footnote is in the original.]
4. See footnote 2, Document 323. See also Foreign Relations, 1981–1988, vol. XLI, Global Issues II, Document 221.
5. See footnote 3, Document 323.
6. See Keating memo to VADM Poindexter, The Security Considerations of AID, 8 July 1985. [Footnote is in the original.]